As the Securities and Exchange Commission worked overtime to finish the Volcker Rule last year, a new arrival warned her colleagues they were botching one of the key parts of the new U.S regulatory machine.
Commissioner Kara M. Stein, who had recently moved to the SEC after a career on Capitol Hill, said the text was full of potential loopholes for banks to dodge the ban on proprietary trading. She let it be known she might vote against it, bottling up the rule and embarrassing SEC Chair Mary Jo White.
In the end, Stein got some of the changes she demanded and she voted for the rule. It was just the beginning of the role she’s come to play at the SEC: A guardian of the intent of Democratic lawmakers who passed the Dodd-Frank Act to rein in Wall Street after the worst economic downturn since the 1930s.
Since becoming one of three Democratic appointees on the five-member commission in August, Stein has criticized the SEC - - and by extension, White -- for weaknesses in rules for crowd-funding and overseas swaps trading. She’s also questioned whether White’s plan to cut risks in money-market mutual funds, coming to a vote this week, will do more harm than good.
“It’s really unprecedented to have a commissioner of the same political stripe object so repeatedly and vociferously to the chairman’s actions,” said Robert J. Jackson Jr., a securities law professor at Columbia University.
Stein, who declined to comment for this story, has said in speeches the SEC hasn’t done enough to clamp down on market risk or punish rule-breakers. She invoked her experience as a Senate aide in 2007 and 2008, which left her “crisis-scarred,” she told a Washington audience last month.
“I want to do my part to avoid ever having to face another one,” she said in the speech to the Peterson Institute for International Economics. “The events of 2008 are indelibly etched into my memory.”
In May, she told the Financial Industry Regulatory Authority, a group under the SEC’s purview that enforces rules for Wall Street brokers, that its penalties are “financially insignificant for the wrongdoers.”
While Stein and White are both Democratic appointees, the gulf isn’t surprising to those who know them.
Stein, 50, graduated from Yale Law School in 1991. She then earned a fellowship to counsel low-income housing tenants at a Dallas legal-aid clinic. She never specialized in securities law, instead spending 16 years as a Senate aide, mostly working on the Banking Committee for Jack Reed, a Rhode Island Democrat, including in 2009 and 2010 when lawmakers wrote the Dodd-Frank Act.
White, 66, served as U.S. attorney for Manhattan during the 1990s where she oversaw prosecutions of terrorists and Wall Street lawbreakers. She later re-joined Debevoise & Plimpton LLP, where she had started her career, representing banks including Morgan Stanley in dealings with the SEC.
“Kara Stein is an outsider to the securities bar and the bottom line is, being an outsider to the securities bar makes you an outsider to this commission,” Jackson said.
In a statement, White said, “Kara brings energy, deep commitment and important perspectives to the work of the commission.”
Stein began her SEC tenure quietly. She assembled a staff that included Tyler Gellasch, a Democratic policy aide to Senator Carl Levin of Michigan, whose committee investigated Goldman Sachs Group Inc.’s role in the mortgage crisis and JPMorgan Chase & Co.’s $6.2 billion trading loss. She didn’t give a speech or sit for interviews for three months.
Behind the scenes, she was more aggressive. During a closed-door meeting last September, she read from a script as she chastised a senior enforcement attorney for what she argued was a failure to take an investigation far enough against individuals related to it, according to two people familiar with the matter, who like others quoted in this story spoke on condition of anonymity to describe private sessions.
Those in the room watched in shock because commissioners don’t read from statements in such meetings and usually meet with staff privately to discuss enforcement cases. The episode hurt Stein’s relationship with some top staff, who thought she misunderstood the law, the people said.
Then came the debate over the Volcker Rule, a Dodd-Frank centerpiece that bans risky trading by federally insured banks.
Stein told the SEC staff that initial versions of the rule contained too many loopholes, according to a person familiar with the matter. Among her concerns: It could allow big banks to invest in overseas private-equity and hedge funds. In response, the SEC tightened the definition of what kind of overseas funds are acceptable, the person said.
Before final action, some of Stein’s views showed up in media reports, which said that she and Gary Gensler, the chairman of the Commodity Futures Trading Commission, were insisting on adding restrictions to the rule. The reports angered White, whose chief of staff, Lona Nallengara, confronted Gellasch, saying that Stein’s coordination with outside regulators such as Gensler could undermine SEC negotiations, a person familiar with the matter said.
Stein’s work on the Volcker Rule won her plaudits on Capitol Hill, where some Democrats have grown dissatisfied with White’s progress on implementing Dodd-Frank, according to a Democratic Senate aide. On a day in June when she criticized the SEC for its slow pace of finishing derivatives regulations required by the Dodd-Frank law, Levin, Gellasch’s former boss, issued a statement saying she was “right on target” and urged the SEC to “stop procrastinating and get the job done.”
Stein also opposed a waiver granted by the SEC to limit the fallout from criminal charges against Royal Bank of Scotland PLC after one of its subsidiaries pleaded guilty to rigging benchmark interest rates. She and Luis Aguilar, another Democratic commissioner, were the dissenters in the 3-2 vote in April, which averted an action that could have taken away the bank’s right to sell new shares faster in the U.S.
Stein’s dissent, made public on the SEC’s website, said the agency’s authority to add another layer of punishment has “the potential for deterrence at large institutions that no one-time financial penalty could ever wield.”
Her remarks sparked an outcry from Democrats such as Senator Sherrod Brown of Ohio and Representative Maxine Waters of California, who cited Stein’s position in June when she offered an amendment to limit the agency’s ability to grant waivers.
“Her dissent captured the difference between the way she and Mary Jo White look at the world,” Jackson said. Stein “takes the view that operating as a financial institution in the U.S. is privilege.”
Legal scholars said the punishment that Stein wanted for RBS is typically imposed on individuals or firms that misrepresented financial information to investors, which wasn’t part of the Justice Department’s case against the British bank.
“You are squinting awfully hard to find the connection,” said Adam Pritchard, a securities law professor at the University of Michigan who previously worked in the SEC’s office of general counsel.
Stein has also voted in favor of waivers, including for Credit Suisse Group AG after it pleaded guilty to helping U.S. clients evade taxes. Last month, she voted against a waiver for BNP Paribas SA that let it continue to operate as an investment adviser after it pleaded guilty to U.S. sanctions violations and agreed to pay $8.97 billion in penalties.
While Stein hasn’t voted against any rules, her style of speaking out about shortcomings rather than negotiating quietly presents its risks.
She has leverage, because White often needs Stein and Aguilar to finish a backlog of regulations, and public criticism undercuts the chairman’s image as tough on Wall Street misconduct.
On the other hand, it’s White who sets the SEC’s policy agenda and manages the staff members who write rules. Last month, for example, Stein provided the staff with 107 comments representing changes she wanted to rules regulating overseas swaps trades. Out of those, according to two people briefed on the process, she achieved one substantive change -- the rules apply to trades where there is an explicit guarantee between the bank and an affiliate.
On the day the SEC voted to approve the rules, Stein, who as a Senate aide helped draft early versions of the law that created a framework for swaps regulation, blasted the agency for “pretending” it lacked the legal authority to extend its rules to even more of U.S. banks’ overseas trades. If a bank might have to bail out an overseas affiliate that defaulted, she argued, the SEC’s rules should apply.
“I have been told that the policy objectives I seek, which are the policy objectives I remember Congress having when it passed this law, are simply unattainable,” Stein said at the June 25 meeting. “That is because, I am told, Congress failed to clearly provide adequate authority to do the job. I disagree.”
Stein nevertheless joined the majority in approving the rule because she thought voting no could make the action look more partisan and cause problems for White with Democrats in Congress, according to a person familiar with her thinking.
When SEC commissioners vote on the money-fund plan July 23, Stein could be a voice of dissent. The proposal would require the riskiest money funds to abandon their stable, $1 share price and adopt a pricing standard that could cause investors to experience gains or losses. The SEC limited the change to products used by institutional investors, who pulled $310 billion from the funds during one week in September 2008.
Stein said in February the agency’s proposal didn’t go far enough to address the role of money funds as lenders in the short-term funding markets, which seized up in the credit crisis.
Among other changes, Stein has pushed for the SEC to impose the floating-share price on funds used by retail investors as well, according to two people familiar with the matter. She also objects to giving money funds the authority to lock up investors’ money when they need to rebuild liquidity, a tool favored by the industry’s main lobbying group.
“Kara has a lot of experience and her instincts are to be a team player, so to the extent she is expressing concerns about the commission’s direction publicly, that should be taken seriously by people concerned about both investor protection and systemic risk,” said Damon Silvers, associate general counsel of the AFL-CIO.